European CMBS Don't Need Liquidity Facilities

Banks choosing against renewing liquidity facilities should have no impact on the credit quality of European CMBS transactions, analysts said.

Barclays Capital's decision not to renew its liquidity facilities for both its Newgate 06-1 and Taurus 1 deals has brought into light the wavering commitment of European banks to renew their liquidity facility business at a time when banks are focusing on an increase in earnings.

"The reputational risks caused by this and potential for reduced business appear of little concern in current market conditions," Societe Generale analysts said.

Under the terms of most renewable 364-day credit lines provided, if the facility is not renewed, it will be fully drawn and held on deposit. This costs the issuing vehicle the difference between the interest paid and that received, which is typically more than the fee for undrawn liquidity facilities, which in turn increases bank revenue.

"Any increase in earnings by making standby loans may act as a disincentive to renew liquidity facilities, even at the risk of hindering future business," Fitch Ratings said.

However, this fee increase would be entirely dependent on excess spread, and in many European CMBS transactions, this relies on what provision is made for extraordinary administrative expenses in the calculation of Class-X note interest.

SocGen analysts said the impact on excess spread is likely to be most felt by deals providing large liquidity facilities and little excess spread.

"For the deals impacted, the Class-X payments will be reduced, saving the most junior tranche from downgrade or default," SocGen analysts said. "The issue highlights risk when buying the most subordinated tranche in Class-X deals, as any shortfall not absorbed by the excess spread strip in the documentation would cause a default, even if of trivial value."

In most CMBS transactions, however, liquidity facilities represent only a "modest proportion" of the deal (the equivalent of a few months' interest cover), and any increase in cost is likely to have a minimal impact on excess spread.

Fitch also added that, in some transactions, the interest earned on the standby deposit and eligible investments is the only extra expense to the issuer arising as a result of drawing down the standby loan, and this would be paid in priority to bond coupons.

In both deals from which Barclays withdrew its facilities, Fitch affirmed the ratings of those transactions.

"Once a bank announces its intention not to renew a facility, it must make available to the issuer as a standby loan an amount equal to the then-outstanding facility to be held in a dedicated bank account," Fitch analysts said. "Liquidity can be drawn from such a deposit in precisely the same circumstances and in the same manner as occurs from an unfunded facility."